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Nicholas Kitonyi
Nicholas Kitonyi
Articles (409)  | Author's Website |

How Does Government Stimulus Affect the Stock Market?

The market has extended gains after recovering from the March plunge

January 18, 2021 | About:

The U.S. stock market has continued to recover from the adverse effects of Covid-19 since bottoming in March. The recovery also coincided with the announcement of a $2 trillion stimulus package that was introduced to cushion personal income.

Last month, President Donald Trump approved a second stimulus package of $900 billion, which again saw a significant share of the amount given out in form of stimulus checks to families and loans to small businesses. This essentially increased the amount of money in circulation in the economy, ensuring sure that spending continues amid the pandemic.

This resulted in a significant gain in stock prices, especially in the consumer defensive sector with companies like Dollar General Corp. (NYSE:DG) and Dollar Tree Inc. (NASDAQ:DLTR) up more than 50% since March.

The continued increase in Covid-19 cases meant that even with the stimulus checks, households were still cautious about premium spending, which in turn benefitted discount stores.

According to a report by CNBC, a big percentage of those whose incomes were not significantly affected by the pandemic but still received the stimulus checks chose to invest in stocks.

Economic stimulus and inflation

Inflation plays an essential role in the stock market. Higher inflation rates tend to result in increased stock market activity, while recessions can be linked to some of the worst stock market crashes of all time. Reflation, which is basically what we witnessed over the last nine months, tends to have a similar impact on stock prices.

For reference, the S&P 500 Index rallied more than 63% since March 20. However, it is only up about 16% since February. Therefore, a huge percentage of the rally came as part of the recovery from the February through March plunge. This is a clear demonstration of a bull run driven by reflation after the rollout of the government stimulus.

In 2020, the U.S. inflation rate fell to 0.62% from 1.81% in 2019 and 2.24% in 2018. Under such circumstances, leading U.S. stock indexes should have witnessed a relatively slower growth than the 63% witnessed in the S&P 500. This is why reflation should not be confused with inflation when assessing the health of an economy. According to John Pattullo, co‑fund manager of Henderson Diversified Income Trust (LSE:HDIV), there is a possibility that reflationary bounce in stocks could be overstated in the short term with more structural corrections not too far on the horizon.

Nonetheless, it could be a long time before the market makes a correctional pullback after President-elect Joe Biden announced a $1.9 trillion stimulus package. This will increase the amount of money in circulation by restoring the purchasing power of the consumer.

In addition, with the Covid-19 vaccine distribution ongoing, there is a chance that structural market recovery could continue, thereby boosting stock market activity. The unemployment rate has already fallen to 6.7% from a historical high of about 14.8% in April.

Looking forward

The latest jobs data also demonstrates a continued recovery despite falling short of expectations in December. More than 20.7 million people lost their jobs in April. Since then, the market has created more than 12.3 million jobs, cumulatively net of the 140,000 lost in December according to the monthly non-farm payroll data.

The recent spike in coronavirus cases necessitated partial lockdowns, which led to job losses. The second series of stimulus checks announced a $300 weekly benefit per person for the unemployed, which should help retain their purchasing power. Biden's proposal is for $400 weekly checks for the unemployed to run through the end of September.

As such, reflation should continue to drive market activity, which will then boost stock prices amid the adverse effects of the pandemic. But when tapering begins after full economic recovery, there could be a significant pullback in stock prices.

Disclosure: No positions in the stocks mentioned.

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About the author:

Nicholas Kitonyi
Nicholas is the founder of CAGR Value. He is a financial analyst with extensive experience in investment research and stock market analysis. His analysis has been featured on several research sites.

Nicholas has solid knowledge of both U.S. and European markets. His investment style is focused on undervalued plays and growth stocks. Nicholas classifies himself as a swing trader and likes to trade GBP/USD, gold and FTSE 100, among other liquid instruments.

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